Spontaneous Order vs. Dionysus vs. Rousseau

Ok, that is a strange combination. But I was thinking about different theories of the group. I have been obsessed with thinking about collective action since I first read Hayek who articulated the idea in a way I had not found in other places. Now I know that collective action problems are everywhere, but it really depends on how you look at them. So I want to break these down into categories:

The ancient Greek idea of Dionysus was of a harvest god, a god of excess. So what do you do when you have a harvest and much of it will cannot be stored for the long term? Well, you feast. The feast celebrating Dionysus must have been quite a few people's favorites, but over time the creation of myth about the god suggested something very interesting. Dionysus as a fetus was ripped apart on the order of a jealous goddess Hera because, as usual, Zeus had been fooling around and fathered Dionysus from a mortal woman. One way that the dismembered god could be re-united is when his worshipers all worked themselves up into a drunken frenzy. Dionysus here stands for the transcendental union of the mob in its most animal form. The individuals have to be reduced to a totally unconstrained state, like an orgy.

The French author Rousseau also talked about where political authority comes from. By trying to imagine a sovereign who most perfectly captured the majority of political will, Rousseau posited that the general will could be achieved in society in at least a relative degree. Rousseau did not have the benefit of social choice theory, nor the intervening scholars that have studied the issue, but he becomes an early expression of approximating a social choice solution at an aggregated level. Arrow would later call this solution a dictator.

Finally there is Hayek. The theory of spontaneous order deliberately rejects the solution of collective action through one mind (be that god or sovereign). In its place Hayek finds that the price mechanism help to communicate information so that totally isolated individuals could get what information they need to move resources in the right direction to everyone in society's benefit. Typhoons cause damage to catfish farms in Vietnam, no need to read the paper, the price rises and people start conserving catfish by eating other foods at the margin.

What is explicitly rejected in Hayek's theory then is that the aim of this process is deliberate. There is no god, no sovereign whose purpose this whole process serves. Looking at the three different cases we note the similarities. All have two levels: social order and individual action. The Dionysians debase the individual in order to celebrate their god, whatever happens happens. Rousseau ignores the minority, which causes some problems that even he would have to admit. Ultimately Rousseau's system is unstable because it is too bold with majority will. Hayek rejects the teleos, the goal of society that Rousseau would want, and the thing Dionysians couldn't care less about.

Hayek, to my mind is the one that cares the most about the individual. Some say to a fault. Perhaps Hayek's biggest challenge is to deal with a world where the minority gets some power or privilege by historical accident or evolutionary failure. Rousseau's majority would take care of this problem, but it would soon start looking like a Dionysian mob because, as far as I understand, Rousseau didn't have a solution for run away majority will (French Revolution). So the biggest question is, in avoiding the mob, are we doomed to have entrenched interests?

Rules and Progress

In his post from Monday, Michael asked the question of what rules are designed to do and gives us two types of frameworks to answer his question: In Rawls’ reflexive equilibrium rules are designed to produce some end state. With Bentham’s rule utilitarianism, the rules are designed to allow people to take risks in the interest of progress (I hope I am explaining this correctly). In talking about Bentham, Michael points out that there is a fundamental tension between stability and growth. I want to draw on Elinor Ostrom’s work to expand on that point a little. I have to admit sheepishly that I read her article on collective action and the evolution of social norms, which was published in the Journal of Economic Perspectives in 2000, for the first time yesterday. The article is a great summary of evolutionary psychology and experimental economics results applied to her field studies on the design of governance institutions. Ostrom reports that to more accurately model the evolution of cooperation, we have to distinguish between different types of actors. She describes two different types: Rational egoists and conditional cooperators. Rational egoists behave like the standard homo economicus. Conditional cooperators will thrive on trust and are better off if the people they interact with reciprocate their trusting. The incorporation of these other agent types helps her to explain why in experimental settings, cooperation exceeds the game theoretic predictions. In fact, it can explain why societal norms and values emerge that support cooperation. Rules that facilitate cooperation can emerge in the real world in the absence of centralized direction. More specifically, it explains how groups of people can overcome common pool resource problems successfully.

At this point you are probably wondering how this diatribe is related to the argument about stability vs. growth. Well, I would like to assert that economic growth is correlated with changes in the norms and values that society is build on. This is not really my idea; I am taking it from Hayek in his Constitution of Liberty where he explains how societal norms change when a critical mass of individuals decides to violate the existing set of rules because they prevent them from taking an action that promotes their own self-interest. Such changes do not necessarily have to occur for the basic norms that facilitate trust and cooperation, but maybe for norms and values that determine what is appropriate behavior more broadly. You might say that such norms are a reflection of the man within the breast from Adam Smith’s Theory of Moral Sentiments. Think for example of the idea that it is somehow repugnant to sell your blood or your organs and the social norm against exchange for such goods, which is based on this intuition. Because of this societal norm, severe shortages of blood and organs persist and people die every day who could be cured easily, if we just got over ourselves already and decided that it would be ok for people to sell their kidney. This is somewhat of a crazy problem if you think about it, because we have all of the knowledge and technology that is required to save people’s lives when they need an organ transplant or a blood transfusion. The only thing that keeps us from actually saving them is the fact that there is some norm that says it would be wrong to exchange body parts for money. If you consider an increased ability to save lives progress, then these norms that prevented people from selling their body parts are in the way of progress.

Now this is very tricky because the same norms that facilitate trust and cooperation in the advanced division of labor can become obstacles to progress and the advanced division of labor. So while they provide for enough stability to allow people to form expectations about each other’s behavior and trust each other, they can at the same time provide too much stability. What I am trying to claim here is that this fundamental tension between stability and growth is determined by the rule structure that governs social interactions. If rules are too loose, cooperation is difficult. If rules are too tight, movements towards increased cooperation become difficult. This brings me back to Elinor Ostrom and the emergence of self-governance norms and rules. If rules are indeed the factor that determines the balance between growth and stability in a society, then formalization of rules will always result in a more stagnant society because it increases the cost of change. Informal rule systems on the other hand will be more fluid and adaptive and therefore better able to facilitate growth. So not only can informal rules emerge in the absence of formal government. Informal rules are also more likely to promote economic growth than formalized systems of rules. Now my question for Michael is the following: Does Bentham propose formalization of rules and if so why did he not favor informal social norms over formal laws (since formalization seems to slow down the rate of progress)?

Rationality, Irrationality, and Ignorance

I should just call this post Leeson vs. Caplan, but what I mean is the versions of Leeson and Caplan I have in MY mind...

Rational action is that which accounts for all the knowledge available, or at least that which would be relevant to the task at hand. Irrational would be to take information that is relevant to the problem and then to conclude falsely without relying on an informational error. Ignorance would be to conclude falsely because of an error in information. One thinks of adaptive expectations and limits to cognition when on things of ignorance.

So Leeson's work describes rationality which is found everywhere. Pirates are rational, the Roma are rational, Trials by ordeal are rational. Leeson is strictly right because he limits the definition of the group more than most people. This is a careful articulation of how the group functions. The pirates behave rationally given that they are on a boat together and are mostly outlaws. In a way Leeson shows that Pirates are more like Robin Hood than they are foaming at the mouth crazies. Contrast this with the way Pirates are typically considered (they destroy the peace as seen from the best interest of maritime travel). Leeson basically stakes his claims on the fact that groups are not ignorant of what it is in their best interest to be aware of, and therefore their behavior is rational (informed and maximizing subject to constraints).

How then would someone read Pirates as irrational. This is where I read Bryan Caplan into the mix. Caplan famously stakes a third category between rationality and ignorance. This category is called is irrationality. Caplan performs this trick by drawing a line between what is in the best interests of individual and what is actually chosen. If you ask the question about what is in the best interest of maritime travel, then you see the P-D game unraveling. The way that Caplan does this is to draw a contrast between what someone would chose privately, if they paid the full cost, and what someone would do publicly, when they free-ride. This standard welfare economics move shows that people will over-indulge when they pay too little cost. So then he says that irrationality is a good, like other goods. But what does irrationality literally buy you?

This is where I am reading into the debate. I start thinking about why someone would want to believe something irrational. Why might Unions believe that tariffs are a good idea (not only for them, but for the US)? Well the union has a position that they stake rationally for their own interest. Then they allow it to be argued as if it were in the interest of the nation. They must know that the interest of the whole nation is better served by lowering trade restrictions. So why might they consume this false or irrational argument despite the availability of very cheap information (so many economists are blogging now)?

I think that the real divide between rationality and irrationality is the demarcation of the group. When groups overlap and when individuals do not pay careful attention to the differences in membership between what North would call organizations (of which each individual is a member of several organizations at different sizes), then what looks like irrationality shows up. Leeson solves this by redefining the group to the point where the actions taken are rational (restricting the organization in question) -- rather than buying the fact that unions are actually arguing for the whole of the US he calls them out and says they are arguing for only the union itself. Caplan, on the other hand, seems to hold the question constant -- in my example, what is good for America. In doing this he allows for irrationality to persist by ignoring how groups define interest itself. This prevents the discussion from falling into a tautology.

I think you need both Leeson and Caplan to discuss the issue. Don't give up the question that is being asked, but consider how individuals define their own interests. Some back-and-forth between the two sides is needed to understand the problem.

More on Rules and a little on Bentham

Diana starts off the latest round of conversation talking about rules. I want to even take it back to a more basic point about rules.

What are rules designed to do?

If we proceed from a rule-utilitarian perspective than we have two routes to follow that I can think of. John Rawls has broken the path so well in terms of his reflexive equilibrium that many may only think of his approach, but I also want to consider a different approach that is less obvious. But first, we focus on Rawls.

The reflexive equilibrium is designed to produce rules that coincide with a desirable resulting state-of-the-world. Rules are adjusted like the throttle of a motor-bike to achieve the desired result. Each throttle is tuned to produce incentives necessary to reach the desired outcome. However, Rawls is not so naive as to not give us guidance as to what these throttles are aiming to achieve (his version of the teleos). The primary purpose is to achieve fairness and the possibility of allowing unfairness is only allowed in a dynamic context if the ultimate growth which results form the difference increases the least-well-off. Well certainly this changes the game for interpreting the rule-utilitarian approach. I defy you to find a better discussion of rule-utilitarianism than that which is surrounding the work of John Rawls. Even in economics, James Buchanan relies heavily on Rawls (both took Frank Knight very seriously, BTW). All of this is very rational and very optimistic about human reason. It also enshrines stability and order in rules.

Now that I have told you want is the standard approach to rule-utilitarianism, I want to go further. What I have discovered in reading late 18th and early 19th century texts is that before it was clarified by Rawls, some other thoughts were out there. The name of the game was to replace the interpretation of morality by clerics and create a secular basis for rationally articulating moral reasoning.

The work of the arch-utilitarian Jeremy Bentham is dripping with moral imagery while simultaneously dismissing rights-theory and organized religion. Bentham rejects what Hume would call superstition and enthusiasm, but he holds onto the subjective. [This last line is my own reading]. So what does a utilitarianism look like that includes this type of pursuit. It is something that is larger than the utilitarianism you have been taught was in Bentham.

For example: Bentham considers the question of committing suicide publicly when one's spouse dies. He considers the utility calculation for the individual to justify the position and to argue against it. Certainly the actor in question could be making an accurate representation of their decision, but also the person could feel as if society has put a great deal of pressure on them to do this. Barring an environment where we were clear about the person's actual intentions we would be against such a practice. We could assume society is implicitly compelling the act. However, were we to be convinced of the sincerity of their motivation to die with their spouse, we would be forced to stand aside and allow it to take place.

For a more pedestrian example, should people who borrow money be allowed to do so at high rates? They certainly are higher risk, but who if not the market should decide about the appropriate level of risk in a society (by bidding up returns)? Too many risk-lovers and the market becomes brittle. The 1997 Asian crisis is one concrete example of excessively brittle international relations. The US banking disaster in 2008 is another example of high risk. So what is a rule-utilitarian to decide? Why is it that Bentham breaks from other rule-utilitarians and critiques financial regulation (famously arguing that Smith's defense of usury laws was inconsistent with other parts of his own work)? Bentham believes that society progresses when people take risks. He also longs for more progress which he defines as a result of risk-taking. To use rule-utilitarianism as it is often used, to constrain growth in favor of stability, is to bias the result. There are types of rule-utilitarianism that favor risk, for example.

Ultimately, I want to construct an analysis of rule-utilitarians that distinguishes them according to their time-preference or preference for the status quo vs. progress. The results fly in the face of conventional left-right dynamics. For instance, social democrats and their penchant for redistribution implicitly believe in lower growth rates than do right wingers who are willing to embrace social mobility and high growth. I argue that the conservative / progressive dichotomy is reversed at least on this margin.

What say you?

Good Rules are a Public Good, Bad Rules are a Private Good

“Civilization advances by extending the number of important operations which we can perform without thinking about them. Operations of thought are like cavalry charges in a battle – they are strictly limited in number, they require fresh horses, and must only be made at decisive moments.” Alfred North Whitehead

F.A. Hayek builds on this insight by arguing that individuals can economize on knowledge by following specific rules of behavior. An individual solves the problem of “conducting himself successfully in a world only partially known to man” by “adhering to rules which had served him well but which he did not and could not know to be true in the Cartesian sense” (1973: 18).

Rules obviously hold an important place in the structure of civilization and, at least in Hayek’s discussion, they emerge out of a process of individual interaction and they change when the benefit of breaking the rule is greater than the cost of doing so to the individual.

More recently, James Buchanan (2011) argues that the process of rule formation cannot be judged based on an efficiency criterion because good rules themselves are public goods. There is therefore no such thing as market processes of rule creation in which entrepreneurs, lured by private profit, can be relied on to continually discover new and better rules.

While Buchanan is clearly arguing that there is no such thing as a market process for the discovery of rules, his argument does not preclude the possibility of analyzing the process of rule formation more systematically. Different social and institutional environments have different systematic effects on the types of rules we might expect to emerge. Take Buchanan’s own distinction between constitutional and post-constitutional rules, for example. They are distinct in the sense that rule creation in the constitutional sphere requires unanimous consent by all participants while rule creation in the post-constitutional sphere does not. If we draw on Hayek to distinguish between good rules and bad rules, we can suggest that good rules will be those that apply to every individual equally and are not designed with attention to specific circumstances but instead hold independent of the situation that an individual might find himself in (generality norm). It is clear that from behind the veil of ignorance, individuals will tend to consent to rules that have all of the characteristics just described. Since they do not have any information about their post-constitutional position in society, they will want to implement rules that benefit all. In addition, because unanimous consent is required, rules that benefit some at the expense of others would not pass even if individuals had knowledge about their specific situation in the post-constitutional position. On the post-constitutional level, however, individuals will be more likely to design rules that take into consideration their specific circumstances and benefit them directly at the expense of others. Because unanimity is no longer required, a majority can pass rules that allow it to extract resources from a dissenting minority. Such rules, by definition, have to violate the requirements of the generality norm.

Taking a more pragmatic perspective, good rules will emerge in environments in which all parties involved can veto the creation of a new rules. Bad rules will emerge in environments in which some are precluded from such a veto. If we weaken Buchanan's claim about the absence of an entrepreneurial process for a moment and assume that entrepreneurial alertness (at least) is omnipresent, we can use the idea of the entrepreneur to distinguish between different processes of rule creation. More specifically, we can say that institutional entrepreneurs in an environment in which they have to secure the support of a large majority of the population will be precluded from bringing about bad rule changes. The problem with the entrepreneurial perspective in this case is that most good rules will only provide small amounts of private benefits to the entrepreneur who discovers the new rule, because they are good rules that do not create rents (which is what Buchanan 2011 points out). In an environment where an institutional entrepreneur only needs the support of a relatively small part of the population, on the other hand, he will be much more likely to extract relatively greater private benefits for himself and his supporters. You can probably tell that this is getting close to the argument about concentrated benefits and diffused cost. As long as there are a minority that can bear the bulk of the cost of a rule and a majority that will reap the bulk of the benefits of the rule, post-constitutional rules will emerge that do not fulfill the requirements of the generality norm.

If you accept then, that good rules usually conform to the generality norm and that general rules rarely emerge in the absence of a unanimity requirement, you will have to agree that the post-constitutional process of rule formation will rarely produce good rules.

Child Care Quality and Regulation

I have been reading and writing a lot about childcare throughout the last year. Something I never thought I would do, but turns out to be quite interesting actually. It is also something I can talk to people about, which I was never able to do with the other things I have been working on. So I thought I would write up the few basic insights I’ve gained in researching this topic.

1. The quality of interactions between a child and its caregiver matters more than the frequency. What follows from this insight is that neither group size nor the ratio of children per staff matter all that much, but teacher training is essential. The cool thing is that the literature in early childhood psychology is in basic agreement with the economics literature regarding this insight.
2. When it comes to teacher training, the most important variable seems to be whether the caregiver has taken a college level class in early childhood education in the last year. This is something that friends of ours have confirmed anecdotally: they have three daughters and they have been hiring female students enrolled in USU’s Family Life Studies program, which combines various fields within the family, human development, and consumer science disciplines, as nannies. Our friends have reported that whenever their nannies have recently taken classes in early childhood development, their kids got to do many activities that are more engaging and would learn new things quickly. In fact, when asked how the nannies came up with the activities they would say things like “We learned this in class a few weeks ago and I thought I’d try it out.”
3. Things that negatively affect childcare outcomes are low teacher pay and high teacher turnover. Both of those variables are highly correlated as you might expect, since poorly paid childcare staff tend to be less committed to their jobs than better-paid staff.
4. European child care facilities tend to have better educated staff that receive higher pay than American day care center staff, largely because limits for child/staff ratios and group-size limits are not as low in Europe (this is not true for all European countries or all American states, but the consensus seems to be that on average child/staff ratios are higher in Europe).
5. One other problem with US childcare regulation is that small family day care homes, i.e. mothers taking care of a few other children in addition to their own in their own residence, are regulated in many states, which makes it difficult for such small family day care homes to operate. In order to operate legally, they have to undergo a number of health and safety inspections (not in all states but in a large number of states). Often, the cost of compliance is too high to warrant legal operation. This type of regulation severely constraints entry into the market for child care provision and as every econ 101 student knows, lower supply results in higher prices.
6. Another effect of this regulation is that because parents are relatively price sensitive, increasing regulatory cost often result in lower staff wages rather than being passed on to parents. As explained above, lower staff wages are one of the main culprits of creating a high quality care environment.

Overall, the lesson that I draw from this is that deregulation of staff-child ratios and groups size limits, as well as the removal of most health and safety standards for small family day care homes would result in better quality childcare outcomes in the US as well as lower prices. Currently health and safety are elevated as standards while childcare quality is largely neglected. Returning some of the decision making rights over how safe a care environment has to be to parents would lower barriers to entry into the child care sector, lower the cost of care, and probably also result in higher wages for child care staff (even though that may seem counterintuitive). I know not all parents may be well informed, but I do think that all parents have enough interested in their child’s health and safety that they would not drop them off at a day care construction site that does not follow any safety standards. Another thing I know for sure is that with snow on the ground 8 months out of the year, day care centers and homes in Utah do not have to have an outdoor play area to provide good care, even though that is one of the things they are required to have.

Deficits, Cognitive Bias, and Thinking Critically about Thinking

In a great book, Democracy in Deficit: The Fiscal Legacy of Lord Keynes, James Buchanan (1986 Nobel prize winner) and his student Richard Wagner (one of my professors) argued that spending is very closely related to reelection and that taxing works against reelection. The argument that we could spend when we were in bad economic times and save when we returned to prosperity (Keynes's countercyclical argument) gave rise to one of the enduring problems with the modern state -- fiscal opportunism. They called the balanced budget idea of government, "that old-time fiscal religion," and argued that only a balanced budget amendment could help save congress from the incentive to shy away from taxes and always increase spending.

California passed measures that has made it in effect a public referendum on every tax cut and every spending increase. This has led to California becoming completely bankrupt with no good way to get out of the fiscal mess. Voters easily vote for more programs and for tax cuts in the same ballot. In fact, people are watching California from China and arguing that democratic reforms could destroy the economy. There is a new assumption is that economic growth and democracy might work against one another.

The very essence of the argument of the republican idea of government was that representatives would have to be held to account for their stewardship of the resources that they are entrusted. I think one way to solve this issue of mis-allocation of resources is to trust them with fewer resources. I have little faith in the idea that we just need to elect better stewards.

Think about this example: In a business, no one cares how many times you failed before you succeeded. In politics, no one admits fault or past mistakes for fear that it will be used against them. This incentive means that dishonesty creeps into the system, little learning takes place and information is sharply limited. The only profit and loss signal is reelection (which is infrequent and clumsy, because it is not broken down to specific issues). Politicians go on TV regularly and refuse to comment on the substance of the issues for fear it will affect their ability to negotiate and vote trade later. It says something about our public discourse in this country that John Kerry's worst mistake was to change his mind in light of new evidence. George Bush's major selling point was that he was above changing his mind. This virtue would ensure a businessman failure, but a politician ought to have this to succeed.

On the other side of the debate are people who want the government to have more power. Obama goes to sleep every night thinking that no one could do a more honest and better job than he is doing. Strictly speaking, he might be right - given that anyone is making decisions for the 300 million people in this country. What these people seem to want is for politicians to make decisions for them. These individuals prefer the myth that there are guards on a wall ensuring that we won't have to tackle the difficult issues. After-all, they are elected to decided for us. This view assumes that only Obama has access to the information about the banks, about the war, about the economy. More trust is needed in his secret files that make it clear which decisions to make. People who have run a business of any size understand the importance of managers seeming to have a clear plan. However, asserting confidence doesn't save the manager when errors are discovered. The plan has to adapt. I am not sure that politics contains the necessary incentives for this to occur no matter who is wearing the hat.

At the end of the day, I have become convinced with the evidence arguing that the majority of how we view the world politically is derived neurologically (Jon Haidt, U Virginia). We can do brain scans and determine the more active centers of people's brains. To break it down to the most important dichotomy, we can look at the left-right political space in this country. Those with a greater portion of activity in the higher-order cognitive thinking areas tend to believe that we can reason our way out of every problem. They don't see natural connections between family members or small group affiliations, they see larger pictures, ethnic groups, political groups, and nations. They then "know" in some sense that greater data collection and more central control will help eliminate "errors" that others are making. Those that have less of this frontal lobe bias, when shown a picture made of dots, see the individual dots and have to have the picture pointed out to them to see it. They are more likely to be religious or traditional in other ways. They see the world made up of very strong social ties. These individuals are the ones that donate to charity, preferring help to come from knows how the one receiving the aid will use it to make themselves better off. Groups are smaller in this perspective and individuals are very meaningful pieces of the whole. These brain types fear outsiders and tend to see reasoning about issues as propaganda meant to ensure compliance rather than agreement.

Of course the frontal lobe types dismiss the others as less evolved. Actually, more research is being done to see if frontal lobe injury makes one more conservative. The implication here is that those that are conservative are brain damaged in some way. Actually, I don't know that this implication holds logically. Any good economist knows that there is a division of labor. The frontal lobe functions are necessary to making well-rounded decisions, but not enough to guarantee that well-rounded decisions are made. Too much focus on high-cognitive reasoning is like Spock from Star Trek. I think that there are good reasons that local knowledge and knowledge of meaningful social connections are important. What we tend to think, at least in academia, is that frontal-lobe activity takes the place of all of the other things that are important to being a well-rounded individual. We have spent so much time defending our nerdy habits that we don't realize the limitations of being nerdy. No one that I know of is doing good research on the impacts of this hypothesis on the political economy. I think it shows that the founders of this nation knew something about people when they wrote the constitution that we have forgotten over time. The reason we need competition between the federal and state levels is to help us balance between high-ideals and the way those ideals come into practice. I just hope that we can account for the goodwill of both sides amid a very frustrating political conversation and economic environment.

Guilt by Association fallacies and Academic Ethics

1) Universities accept private money for buildings, professorships, and other uses.

2) Little of this comes without normative implications and either explicit or implicit quid quo pro.

3) This has been the case for centuries, and in fact is the oldest model of academic funding (think Phillip of Macedonia).

I have recently been made aware of the political interest in universities that receive private funding. Considering that university professor's emails are public documents, we have plenty of evidence about what discussions were taking place about accepting money from private donors.

Does anything actually contribute to a substantial claim of ethical violation? No.

However, that truth seems to easy to dismiss in the age were scandal and the whiff of guilt is enough to start political movements.

It makes me very sad that academia stoops so low as to be susceptible to innuendo.

Being both a large oil refiner and a fan of free-markets is ipso facto proof of ethical corruption. I struggle even to care about logic that is so flawed, but yet it fully depresses me.

Standing Still

It is appropriate to acknowledge a long gap in posting.

What is it about standing still that creates a fear of starting out again?

Momentum is the life blood of academics. In thinking about the gap in blogging all I can offer to explain it is the existence of final exams. This has somehow created enough reason to ignore the blog. I know I was more productive when I was blogging each day, but was that because I was less exhausted or does the causality run in some other way? For example, discharging a thought or two as the day began allowed me to refocus on the tasks at hand while preserving my notes about what I woke up thinking about.

Well, I will see if I can get out of this torpor now that the semester is over...

Academia: A Handshake Culture?

Gone are the days where the choice of the correct tweed jacket was all you needed to signal membership in the fraternity of academic teaching, speaking, and publishing. However, it seems that for every student who overestimates the depth of insight and limitless pool of expertise that their professors have, there is at least one student whose contempt is palatable.

Perhaps this is best described by misunderstanding the portion of the job that is spent outside of the classroom. It is hardly surprising that when academics present the same paper at conferences year after year without making any progress the average student sees a very low bar. However, this should not really be the case in the modern university since people willing to take the job are numerous and the typical person able to qualify for tenure craves the attention that a new publication affords them. So where does this idea of intellectual laziness come from?

Perhaps the non-tenure track lecturers are responsible? The contempt for the system might be very real among these instructors who value teaching without research (if such a thing actually exists). Perhaps students simply haven't understood the complex reward mechanism associated with tenure. Perhaps the student's immaturity makes them look at the world as who you know and not what you know.

I certainly can relate to the idea that professors are parroting warmed over insights from a instructor's manual. The incentives are such that the less time you spend on prep the more time you have for research. So even very competent researchers would have an incentive to use the teaching materials available from the publisher. An interaction between this lack of prep and lack of pedagogical instruction for the research faculty can breed the type of contempt I see among students.

But this still leaves the idea that all research grants, publications, research appointments, and other gigs on campus come from some club which is anything but transparent. As a economist and big fan of the market mechanism for revealing information, this is perhaps a fault of a system that is protected from competitive forces. However, the longer I spend in academia, the more convinced I am that there is a meaningful division of labor. Some people do very detailed work and are bad at promoting (much less explaining) the significance to the wider public. Some are very good at expressing themselves, but find the underlying research element challenging. Some are highly mathematical, good at expressing themselves, but can't publish. Still more are very adept at understanding the politics of the university and add value as administrators. Others are very effective managers over research projects and create synergies from otherwise frustrated researchers.

All of these categories are needed, but each comes with a weakness. As a student it might be easy to look at this collection of weaknesses (taking attention away from the classroom) rather than at the collection of strengths. I wish the advantages of these different personalities were more clearly defended, perhaps in something like a price mechanism. Good teachers should be compensated according to the the value they create among the tuition paying students. This might be the biggest source of the critique for students. Good researchers should be rewarded in proportion to their ability to publish. People who are able to act as good managers and increase the productivity of their research team should also be compensated. There is no one model, nor should we ever pretend that there is.

For everyone who relies on a firm handshake to get things done in academia, there need to be several others that are nose-down researchers who can rely on these people to do their job consistently and without penalty. To be an academic with no sense of politics, we need some people to manage effectively. There also need to be good teachers who can communicate effectively. Rather than denying the division of labor, let us embrace it.

Internet Retribalization and Politics

In a TED-talk I watched a couple of weeks ago, Seth Godin argues that the internet has retribalized society by allowing people at the fringes with similar interests to find each other. Basically, the Zappos family blog has brought together shoe lovers, if you like coffee you will follow the Coffee Sage, and if you are an Austrian economist, you will read Coordination Problem. By finding others with similar interests in this way, people who used to be at the fringe of society have moved to the center of their specific social network.

As I was listening to Godin talk, I started thinking about the implications of this retribalization on politics. My first instinct is to think that a larger number of better-organized small groups make for even more rent seeking and redistribution a la Olson (1965), Tullock (1967), and Stigler (1971). On second thought, however, it does not seem like such interest-sharing groups are really involved in political activism or even designed for this purpose. So far, they seem to exist only for informational and socializing purposes. This might be an artifact of their recent emergence. Maybe they just haven’t figured out yet that they can profitably lobby government for redistribution in their favor. It would after all take an act of political entrepreneurship to make that leap from being organized as a social network to finding a politically profitable niche (See my paper with Randy Simmons and Ryan Yonk on Bootleggers, Baptists, and Political Entrepreneurs in the Winter 2011 Issue of the Independent Review). If such groups were to start spreading into the political arena, what would be different about the type of lobbying they might do as compared to the traditional K-Street-type lobbying we have mostly observed so far, and what would be the implications of their different lobbying activities?

First, and most obviously, internet-based groups would most likely make greater use of informational campaigns than existing groups. Rather than contributing to campaigns by giving money, they might use their existing social network to spread information about a candidate or a specific issue. The trend towards internet-based retribalization, which Godin describes, seems to come with an amount of information sharing across group boundaries that is much greater than what is common for non-internet based groups. Everyone is familiar with the importance of social media in many of the recent revolutions in the Arab world. Similarly, you-tube stars have made it into the world of advertising and at least one homeless person has found a job. Such a shift towards more informational campaigns would also be in line with the most recent Supreme Court decision on the issue of campaign finance legislation (Citizens United v. FEC), which effectively removed restrictions on electioneering communications.

A related second point of comparison to existing lobbying groups would be the ability of the new internet-based groups to operate on a higher level of public opinion rather than through direct congressional influence (pre-constitutional rather than constitutional or post-constitutional, see my working paper with Adam Martin on Two Tiered Political Entrepreneurship). Rather than going through the established channels of forming a PAC for representation in Washington DC, internet-based groups could conceivably influence policy making by organizing internet-based protest. While popular opinion might only be a weak constraint on congressional decision making, it does seem to be a proximate cause of policy.

Third, such groups could most likely organize previously unseen fundraising campaigns. Just remember Ron Paul’s 2007 Money Bomb, which generated $4.2 million in one day, making it the largest one-day fundraiser ever at the time. The significance of this point might be limited for fringe issues, for which support remains low. However, if a small group is well connected, it can conceivably overcome the disadvantage of a small member base.

These three potential changes to traditional influence suggest that if more internet-based groups should indeed become politically active, they would make public discourse more competitive (because they would be able to generate greater amounts of funding), less congress-centric and instead driven more by public opinion (because they would affect public opinion to change legislation), and more information based rather than influence based (because their campaigns would be informational campaigns rather than influence or money campaigns). Overall, such a trend towards more competition, more information, and more active public opinion sounds like something that could actually make the world a better place.

Leontieff function as it applies to Professorship

The above function suggests that you are only evaluated by the measure in which you do the least well. For economists this is simple, it is a perfect compliment arrangement. It is an extreme case. But when you are preparing to appear in a formal setting, you don't want to know how many shoes you have to chose from to wear with your tux, you want to know if you have one right shoe and a left shoe that matches. Having 5 right shoes does not solve the problem.

The opposite case is a perfect substitute. In professorship many people assume you can either teach well and then not do research or research well and not really excel at teaching. This is not the case. I should point out that teaching well is hard to measure, so we proxy with teaching evaluations.

To some extent the idea of perfect compliments can only occur if the supply of people with moderate ratings on both margins is high. As labor is scarce, quality is sacrificed. However, there seem to be many people that would like the job. It is easy to see that someone needs to be a good researcher in order to be effective in the classroom. Who wants to hear a lecture from someone that is still teaching something they were forced to learn in grad school, good teachers update (good researchers update).

Why might it be the case that you need to be a good teacher to be a good researcher? What about the division of labor? Communicating clearly is very helpful in research. Too often people get rewarded for tweaking a tiny aspect of a model or having the only access to a data set. Just like judging students based on one GRE test, judging an article based on access to data or a particular methodological tool fails a robustness check. I can't exactly explain why a good researcher has to be a good teacher, but it seems to make sense to me. Maybe enjoying the classroom means that a good researcher will stay productive over a long period? I am open to thoughts on this.

Selfish Reasons to have more Kids: Chapter One

Diana and I read the introduction and chapter one of this new book by Bryan Caplan last night. It was very entertaining and very well written. I enjoyed reading it out loud and it was easy to listen to as well. This to me is the mark of excellent writing.

The case is made that parenting can be much less of a chore. It is interesting to read things like: if you are considering hiring a babysitter, do. The logic is economic. The last hour you spend with your kids is the hour you are going to be the least attentive, the hour you least enjoy, and the hour that you most need rest. So hire a babysitter if you have the means. Comparing the use of those dollars with almost anything else you can do with the money you would be doing your kid and yourself a very large favor.

I didn't quite understand the comment that the rich already know this lesson. Perhaps it is because the marginal utility of each dollar is lower and they have experimented more? The book wasn't too clear on this point.

The first chapter is framed by the question: Are people happier with or without kids. The couple with kids is happier than the single person without, but Caplan gives reasons why this might be so. Even if it is true, it is far less important than people make it out. Chapter one: If you thinking about having kids, maybe you won't be exactly as happy as you are now, but you will be close. The real action is in having the second kid, even less of an impact on your happiness.

I am looking forward to reading the rest of the book. I assume there will be more reasons that single childless people are not as truly happy as they seem. So far, we know that there are a bundle of things that correlate with happiness. I wonder if they are all independently caused or caused by the same thing. Right now I suspect that there will be significant joint causes for happiness that also predict having kids.

Regulation or Market Process

The current CAFE standards regulating fuel efficiency expire in 2016. The president's administration is currently working on proposals which will extend these over the next horizon and make them even stricter.

However, for you and me, the real reason that we are conserving on fuel and looking for more efficient cars is because the price of gas is rising. The quick knee-jerk market reaction here is to claim that the market is the side that binds and drives progress.

My first reaction is one of public choice: Politicians are just taking credit for something that is occurring anyway. But then, I think a bit more about the problem. Oil prices would not be so low if there were not so many subsidies for fossil fuel, and so many other programs which allow the industry to sell oil at prices below cost. The President seems to understand the need to deregulate, but why am I sure that this will never happen?

Instead of subsidies for alternative energy, we can remove the subsidies for oil which counteract the incentive for supply side research by keeping quantity demanded of oil higher. By allowing oil prices to rise, the search for alternatives follows the market path of substitution given movements along the demand curve consistent with higher prices and lower quantities demanded of the good in shorter supply and higher quantities demanded of the alternative good.

What the government policy is doing is not only taking credit for what is occurring, raising CAFE standards as oil prices rise, but it is also interfering with the market for alternatives. I think that were the government to take a neutral position on transportation energy we would see far more change in how we drive than we are currently seeing. I argue then, that they are both taking credit where credit is not due as well as not taking blame for mucking up the signals between alternative goods so that the evolution of technology in transportation is slowed.

Predictably, I have faith in a market process approach. Rather than love the market when it makes you look good and muck it up behind the scenes to justify continued intervention, maybe we should simply remove the "quasi-" part of the quasi-market solution and reap the rewards of private incentives before we burn another decade's worth of petroleum at ever increasing prices.

We didn't learn anything - Subprime is Back

Friday’s Wallstreet Journal front-page headline reads “Subprime Bonds Are Back.” The article explains that prices in the subprime bond market have recently doubled from 30 cents on the dollar, which was the lowest point during the crisis, back to 60 cents on the dollar. And not only that, non-agency bonds, i.e. bonds that are not backed by Fannie Mae or Freddie Mac, are also experiencing higher yields. Oh and WSJ is happy to suggest that ordinary borrowers are benefiting from this renewed interest in the subprime market because banks are now willing to lend again; they even give out jumbo loans for as little as 5.5% for 30-year loans. The article further reports that several regulatory changes “that have taken place over the past two years are encouraging traditional investors to take a second look at the [extremely risky] assets.” Specifically, state insurance regulators have reduced the requirements for how much capital insurers have to hold against residential mortgage securities, if the securities are bought at a discount.

My head is spinning as I am reading this. This blatantly obvious return to pre-crisis risk taking seems insane, especially when it is reported as if it were ‘good news.’ Isn’t one of the potential explanations for the crisis related to excessively leveraged households and banks? How did state regulators decide that responding to excess leverage by reducing capital requirements for investments in mortgage securities, which effectively makes it possible to take on even more leverage, was the right thing to do?

Now you might say, well maybe the housing market is recovering and this is just the return to normal. Homeowners that are still around, even if they are part of the subprime market, will eventually repay 100 cents on the dollar they borrowed. Another argument that might make this new trend seem more reasonable is that the probability that homeowners will not default on their mortgages is probably greater, if they made it through the last crisis. However, the economist reports this weekend that the U.S. housing market is still in recession, in fact “the S&P/Case-Shiller home-price index for 20 cities fell by 3.1% in the three months to January from the same period in 2010,” that sounds to me like foreclosures aren’t over yet.

Don’t get me wrong, my private learning curve is not very steep either, but it is still sloped positively. This looks to me like a negative learning curve for financial markets. Ridiculous regulation (like those lower capital requirements that the WSJ reports) has destroyed knowledge and reason has completely gone out the window. I guess I should not be surprised. We know (from Mises, Hayek, & Kirzner) that learning in a market context requires both profit and loss. You only know that you have discovered, developed, or produced something valuable, if you can sell it profitably to other people. Similarly, you know that you are doing something wrong with your scarce resources, if you are making a loss. This means that losses are just as important as profits for a market to function correctly and to create useful things. When either of the two signals is distorted, markets don’t do us any good; in fact, they can destroy value. This is what happened in the Soviet Union and it seems to be happening in financial markets currently.

When the federal government intervened to soften the crisis, the treasury and the Fed bought insolvent banks, which should have realized losses. Those banks and financial institutions would have foreclosed without the intervention, instead they were rescued and continued to operate. That means they did not learn anything about excessive leverage and risk taking. They did learn one thing, however; they learned that no matter how much risk they take or how much money they lose, their executives will go home with a lot of money at the end of the night. Looked at from this perspective, it makes sense that they would go right back to making the same mistakes again. Almost no one in the banking industry had to suffer any losses, because fiscal + monetary policy disabled the profit and loss system, so no one learned a lesson. Are you ready for the next financial crisis? Looks like it is just around the corner!

Learning through Adversity

Economics, as a science, can only advance if it takes on the hard questions.

Learning is a theme on this blog as I started the conversation here talking about how to best improve as a writer. Knowing very precisely how bad one is as a writer helps to outline what needs to be done in order to progress. The more potential for progress the more inadequate one feels. This even translates to mind-numbing feelings of inadequacy, at times. It was for this reason that I chose the title, "off-the-cuff" and the German word unvorbereitet for unprepared or extemporaneous. Acknowledgement of short-comings removes one of the biggest obstacles to learning.

Economics has developed a fetish as a hand-maiden to political power. There is always an economist that can back your basic story and conveniently we, as a profession, have access to statistics that can remove criticism beyond the ability of a casual observer. Being certain pays in the marketplace of ideas and quantity supply increases. At GMU we questioned methodological barriers to entry because, like all barriers, it prevents true competition. It has remained my instinct to avoid the assertion of expertise or those that think they are done learning. Rather, I am careful to see knowledge from a particular angle with almost debilitating numbers of caveats.

The longer that I spend in the academy, the more I understand that time is scarce. Energy is scarce. Who can both succeed as a professional and be clear about the limitations of science? It makes me appreciate the value of folks like Matt Ridley and Richard Dawkins who are privately funded as advocates of popularizing science. I am now familiar a few books by both authors and am impressed with the energy they bring to their sciences and the crusader's will to discover what it takes to teach their subjects. After all, what impact does science have on society if its central tenets are misunderstood and the consumers have no avenue to decode them?

I can't help but be frustrated, however, with what I see as a willingness on the part of the standard professor to assert expertise over a whole variety of topics, but to not admit to their students the real deficiencies in their own depth in these subjects. Professors that pull it off well, that is distinguishing where they are experts and where they lack expertise, are loved by their students. The student humanizes the pursuit of knowledge only when you tell them that, like you, they are beginning a search or a journey of the mind.

The academy rewards self-confidence, but the search for truth only rewards humility. How can we teach this lesson to our students? More importantly, what are we doing to remember this lesson?

Signaling Stupidity to Appeal to Others

Ah, Facebook...

I get to see the types of things that my former students are thinking about. Lately, one commented about a piece in the student newspaper that failed to live up to his expectations. In the piece a student talked about her new found willingness to accept the idea that there may not be a god. This is only particularly newsworthy on my campus because people reading the piece can be assumed to believe in at least one god.

My former student was particularly offended that this published article confused theist and deist. This told him, in combination with the general tone of the article, that this person was just beginning to explore those thoughts about life and the possibility of no afterlife. His objection seemed to be that someone should reflect more before publishing such a piece.

I admire this student's high standards, but my comment to him was that the student may in fact know her audience well. Being too bold, or even, as the title of this piece suggests, being too smart -- could turn people off and mean that the article would have limited impact. If my former student were to write the article, it probably would be sophisticated, insightful, and boring to the very readers this student is trying to speak to.

I have noticed for a long time that being technically accurate can be a turn off. Being raised in the South, there is a strong requirement of embellishing that is important for communicating, or what should be called: storytelling. The "Truth" (capital T) is of very little value outside of a scientific or criminal context. In fact, I quickly realized in the south that the kind of persnickety-ness with regard to details was frowned on generally. I had to learn this in the context of my post-graduate education and I still hold some of the embellishment from these formative years.

Just like Mary Poppins said, a spoonful of sugar really helps with the medicine. Similarly, a great big pile of colorful interpretation might help with making big idea appeal to a wider audience. Someone ought to work on the power of these rhetorical approaches vis-a-vis communicating the kernel of ideas. I have always thought that fables and proverbs do a great job of communicating complex ideas and lessons. How effective would they actually be if they were forced to be accurate?

Libertarians and the Law

In a relatively casual conversation over dinner last night one of the dreaded topics came up, abortion. Now as a libertarian this can be an easy issue -- or it can become a divisive one.

In the 1970s the issue was no more than women's rights. Period. The libertarian position was that women have the best access for control over their own bodies.

Being a good guest, I did not argue with my host when she said that abortion is murder. This is a position I largely agree with. I would make the more technical claim that it is killing, but not murder.

Because of my firm commitment to methodological individualism, I presume that I could get very upset about the role of abortion in the legal system. However, over the years I have come to think about this issue in very textbook terms. I have sterilized the subject primarily because at the age of 33 I know very few people who are in the position where they must abort a baby in order to still have a life that matches their expectations.

I guess my major concern with the argument --

1. murder
2. law provides for protection against murder
3. we like that law provides for the protection of murder and we want to keep it
4. abortion is murder

-- is that I don't really understand the role of the state here. The state is an apparatus that was designed to provide consistent expectations about the behavior of other people. I have to think that there is a sufficient penalty against murder in order to remove this option from the set of means to get what I would like. The state then is a collection of negotiated rules that are rather regularly enforced. Some rules are irregularly enforced, sure, but murder is one of the most regular.

If we want to talk law, let us talk law: I cannot escape the logic that killing a fetus is related to killing a person. This is an interpretation of reality. It will largely determine your view on the subject. But let us assume that killing a fetus is killing a person. Should a woman have the prior right to be without child? Granting this right would mean that the fetus is trespassing. Safe Harbor laws would suggest that unless the fetus poses a threat the host has to allow harbor. Now, what about contributing to the cause of the fetus being there. If the woman knowingly engaged in sex without precaution during her fertile cycle, should this be enough to remove her right to expel the fetus? Even if we grant that a woman has a prior right to be without child, this still allows certain prohibitions against expelling that child into circumstances where it will not be able to survive independently. In cases where the woman had no voluntary role in creating the child then it seems clear that she can be a good Samaritan or not, again assuming she has this prior right. I think the law can certainly be used to discuss this issue.

But it does not seem to be an issue of law. It is an issue of moral aesthetics. Where I sit, a 33 year old male with a stable and nice life, the issue can be viewed as one of morality. I have that luxury. Were I to leap from the theoretical to the actual and constrain someone else's ability to act, I ought to have the most firm legal backing I can before I begin to make the legal argument that abortion is murder. As someone who has spent some time around libertarians, I do not think a consistent libertarian can start and end on the abortion is murder argument. I rather believe that the law has to articulate the set of actions that are taken responsibly from the individual's perspective. Our moral repugnance tells us that we have identified a need for improvement in this area.

The Three "P"s and the Three "I"s

I channeled my dissertation advisor today and started to teach his rule, you can't get the three "I"s without the three "P"s.

This means that (P)roperty rights, (P)rice mechanisms, and (P)rofit and loss signals are all necessary to get (I)ncentives, (I)nformation, and (I)nnovation.

For the Incentives we have a large body of economic thought which develops the conflict between pro-market and anti-market types over the role that property rights play in aligning incentives.

The basic or first-approximation approach, I argued, was to simply point out that there was free-riding in the absence of well-defined property enforcement regimes. If you simply say "to each according to their need and from each according to their ability," this will end up with little accomplished in groups larger than a family. The next step is to teach the tragedy of the commons. The result of this story is that common property does not work well. Taken literally, the commons could be sold as private property and much of the problem would go away. So far the property rights story seems to be pretty solid.

There is a breakdown when we get to the story of externalities. Because externalities indicate places where property rights are ambiguous and are difficult to enforce, we don't necessarily think that property rights would be easy to define. In the case of planting flowers in your front yard, excluding those that refuse to contribute to their upkeep might be prohibitively difficult.

So, this leads us to a debate, one that is complex and difficult. Without the informational component of prices the property question would only move the debate to the abstract and theoretical level. The beauty of Mises and Hayek is that they make the informational argument so central to their discussion that it does not require the removal of all ambiguity about assigning property rights.

The only limitation that I can think of to the informational argument is that some things cannot be priced. I don't put a price (at least a money price) on love. There is something in us that resists the application of strict measures of scarcity to love. Now, this doesn't mean that we can't compare the marginal benefit another hour with our chosen special one gives us with the marginal benefit from something like writing a blog post. What it does say is that these calculations are going to be more difficult when the market is not thick and the transactions are not cleanly observable. Who is to actually price my preferences but me?

The final leg of this discussion is in Schumpeter. His creative destruction relies on change and it is no accident that Hayek in "The Use of Knowledge in Society"ends with Schumpeter (even if he is critiquing him). Schumpeter allows for change as the entrepreneur recognizes the opportunities to put innovation into effect. Schumpeter distinguishes between innovation and invention because invention doesn't do any good until it is applied to some purpose. The very possibility of change makes economics necessary (otherwise we would only solve the economic problem once and be done).

The link of these three "I"s to the Three "P"s is strong. Prices generate information, but only in the presence of profit and loss. Property rights give incentives and help prices to form better information. Innovation is not possible without some picture of the world created by the entrepreneur who has local knowledge.

Thank you Peter B.

Schumpeter and Innovation

Schumpeter is famous for creative destruction. However, what happens when the destruction is emphasized more than the creativity? What if the creativity is not immediately obvious?

Did anyone know that Velcro would be the next show fastener when it was created? I doubt it. Some discoveries are made by mistake. Most searches for particular answers take you down paths turning out far different than you would have thought. Many prototypes are far different than their mass produced grandchildren.

For these reasons and more the existence of creativity might be hidden, but the existence of destruction is highly visible to those that experience it. For many romantic reasons we think of people that have been doing something a certain way for generations as unimpeachable. However, there is asymmetry toward those that come up with a more efficient and exciting way to do something. Is this because early adopters are just really bad at sharing their enthusiasm over the new products?

In grad school we used to say all the time: "The market loves you," every-time some new consumer surplus was identified. This also manifest itself in Deidre McCloskey's line: "Why are there no folk songs for capitalism?"

Schumpeter's thesis in Capitalism, Socialism, and Democracy can be summarized in the following way: Over time people focus less on the creative and more on the destructive. This suggest something like constant attention paid to the misery that is created by changes over time while the possibilities that are opened up are appreciated at decreasing rates over time. If we plot these, we get a equilibrium where the line crosses the decelerating function of creativity (like the Solow growth model, for those in the know).

This means that unless creativity is actively appreciated, it can be lost in the complaints about how so many are being left out of the advantages of the modern world. Nassau Senior suggested that the luxuries of today become the decencies of tomorrow and the decencies of today become the necessities of tomorrow. This theory suggested that people's expectations change over time about what is necessary. Today's necessities include a color TV, for even the most poor people in the US have this item, considered a luxury 50 years ago. The case for access to medicine is the most striking. Hardly anyone could have heart surgery 50 years ago. Now it is often covered for everyone with health insurance.

What a dramatic change! I think what Schumpeter and Senior teach us is that we need to compose the folk songs for capitalism. Don't be ashamed to sing loudly and proudly about how much the market loves you. If you don't love it back, progress could leave you.

Julian Simon will never be wrong because of the entrepreneur

In his post from Friday, Michael discusses Baumol’s thesis that some industries respond less to capital augmentation and high cost of labor than others do. He suggests as an example health care, which is very labor intensive and will most likely remain labor intensive because a significant part of the service itself is human interaction (unlike haircuts maybe).

Michael explains that because of the existence of such goods, he is not comfortable with the argument that high cost of labor, or high opportunity cost generally, provide a sufficient incentive for innovation. Michael’s main concern is not with health care, though, but instead with oil and specifically transportation fuel. Basically, the question is, what happens if the high opportunity cost of using oil are not sufficient to generate innovation that will lead us away from a dependence on oil? Oil is getting more expensive and it will most likely continue to get more expensive for the near future (note that this does not really have anything to do with capital augmentation). We have not yet come up with a good alternative transportation fuel, however, or for that matter with a good alternative substance to make plastic with (corn based plastics* excluded). Therefore, my interpretation of the implication is that we might need to intervene somehow (Note: this is not Michael’s claim!) to bring about innovation and the development of substitute energy sources.

So, here is my shot at a defense of the market advocates against intervention: I thought about it for a little bit but I could not think of an example of the destruction of a civilization that was caused by the high cost of a product or raw material. I might just be oblivious though, so I would very much appreciate any examples you know of. Most of the time, when a civilization declined, it is pretty easy to trace the causes of the decline back to political institutional factors, not the depletion of a resource (I am thinking Rome, the Dutch Republic, Ancient Venice …). That leads me to believe that market advocates might not be so wrong after all, when they argue that innovation in the market place is a function of increasing opportunity cost. We humans are great at finding substitutes for things because we are really entrepreneurial, especially in the face of high opportunity cost. So we will find an alternative transportation fuel and we will reduce our dependence on oil, because higher prices are a sufficient incentive for entrepreneurial innovation. And because we have always been able to do so in the past.

You might ask why we do not respond the same way to institutional failure, i.e. why do we not innovate and find a substitute for a political institution when it is set to ruin us? Well, Mises and Kirzner would probably say that it is because there are no price signals in politics. Without price signals, it is impossible to fully internalize the costs and benefits of any action. When you do not fully internalize the cost of your action, you are a lot less sensitive to the high cost consequences of your actions. One of our neighbors has a dog, which runs around by itself all the time and does its business in the yards of the entire neighborhood. The dog’s owner does only bear the full cost of his dog’s business, if it is done in his yard. He therefore does not care to keep a tighter leash on his dog. Similarly, when you cannot fully internalize the benefits of your action, you are less likely to innovate. If I do not expect to have full property rights over a cure for cancer and the proceeds from its sale, I will not look for one. In politics, entrepreneurs who come up with institutional designs that could safe us all are not systematically rewarded (other than with fame maybe). Therefore, they are less likely. Entrepreneurship is absent, or at best unsystematic.

Given this understanding of the relative likelihood of entrepreneurial solutions to problems in markets vs. politics, I am lead to believe that we are much more likely to find a substitute for oil and a cure for all of our environmental problems in the context of the market than we would be in the context of regulation or politics generally. Therefore, my response to the argument that some production processes are less likely to experience capital augmentation is “So what?” and “It has not hurt us in the past.” We will find a substitute for oil and we will be fine. In short, I am with Julian Simon.

_____

* As an aside, we have had a spoon made of the plastic alternative stuck in our front yard for about 7 months now and it has not bio-degraded as advertised.

Baumol Cost Curse / Disease

Modern economies are wonderful things. If you really want to re-enact the middle ages, you should eat a healthy portion of your own soil or insects and develop scurvy. Not to mention let go of a few of your personal liberties.

Baumol's thesis concluded that while productivity was rising virtually across the board, the hidden cost was on things that respond little to capital-augmentation. His example is a live-orchestra. It took 250 people to perform a concert in 1750 and it still does today. Now, I have always laughed off this concept because compact disks and MP3s have made the marginal cost of listening to this performance virtually zero. But in 1993 Baumol resurrected his thesis by applying it to health care, and this was published in my favorite journal:

If you think about health care, you will start to realize that good health care is a function of personal relationships -- services. These relationships cannot be augmented by machines the same way that you can get more widgets from a worker by giving them a row of widget stamping machines and training them to monitor and maintain the machine. For pressure ulcers (bed sores), as one example, the patient needs to be clean, dry, and massaged on a routine basis (the sore develops local gangrenous material as a result of damp skin that has insufficient blood flow, a similar to trench foot anywhere there is contact between your body and the bed). All attempts to mechanize relief to this problem seem to fail.

In medicine you need highly skilled people to do tasks that are difficult to scale. Like someone who learns to play a violin, a proper nurse is a very talented artist. Because the increases in productivity here are small, the cost of the level of service rises in proportion to the opportunity costs.

Market advocates might respond that when the opportunity cost gets high enough, the incentive to find a capital-based solution will be so great as to create the needed innovation, but I am not particularly comfortable with necessary but not sufficient arguments. Similar to the market response to the energy crisis, the rising price of oil creates a necessary but not sufficient incentive to innovate alternative energy solutions.

I will continue to work on this idea and most likely post additional comments on it. I would love your thoughts!

Experts and Non-expert Experts

As a professor, much of your identity is wrapped up in how people see your profession or discipline of study. Much of this might come from a value judgement made during a survey course the person took in undergrad or the TED talks listened to while the individual worked out.

Economics is special because it suffers from the attention of almost everyone. Diana posted on Sunday that Krugman has two persona, the nobel-winning economist who pushed out the frontiers of the science, and the NYT columnist. It is this latter character that we encounter in the campus community and that I encounter when talking with my family. During the 2008 election cycle, I actually tried to talk to my family about the economic issues. They looked at me dumbfounded and said: Isn't there a consensus in your profession? Why would you disagree with the nobel prize winner?

Diana focuses on the political nature of this, but there is something really banal about expertise. Non-experts remain resilient to economic arguments in the face of a real-live economic discussions rehearsed live in face-to-face contact. I can only assume that Diana and I are unconvincing as experts.

The one thing that the process of education has taught me is that nicely wrapped packages of ideas in academics should be avoided like the plague. Anything which appears simple is deceptively so. The industry of wrapping complex ideas into sound bytes is one that I begrudgingly accept as permanent. How do we then deal with the popular wisdom of our profession? It is unlikely that a physics professor encounters people remaining confident about some of the cutting edge research in string-theory despite being told that they are omitting a key argument. Even if I have watched 200 TED-talk like summaries of string theory I am likely to defer to the expert on matters of physics.

Why is that different in Economics?

The difference appears to be the normative content of economics. The string-theory implications that would destroy much of the European enlightenment consensus in science are small shock compared to that which the economic rhetorician encounters on a continual basis. Economics can be used to justify almost anything. There are as many arguments as there are people, not only because preferences matter, but because the facts are diverse enough and people lean on statistics for almost point they would like to score in a political debate. Do you think that growth would be higher if we had spent twice as much on road construction? There is an economist that has rate-of-return figures to back you up. Do you think that government spending is wasteful vis-a-vis private infrastructure development, just search the web for papers on that and contact your expert. Seeing that these are not contradictions but compliments means that you are thinking like an expert, not an opportunist.

It takes a practitioner of economics to point out the strengths and weaknesses of these arguments. The practitioners for hire, the public intellectuals, are certainly there simplifying the issues and removing the necessary complexity for the consuming public. But just like the history professor that Diana encountered, this false confidence gets you something rather dangerous. When non-experts confuse these public intellectuals with the authority of a decided professional opinion and start to spread this misinformation, we have a responsibility to reinforce the lesson of ambiguity. Paul Krugman and TED talks are no substitute for actually studying a subject. It seems that in the later case we are more willing to learn the lesson.

Trusting Markets and Not Getting What you Want

While watching "Goodbye Lenin" a few years ago, my friend Adam made fun of me. We were watching the beginning of the movie where the mother of the main character dictated letters to the socialist manufacturers giving feedback on the products they had produced. She felt it was her duty to the common good.

The implication was that this is what I do, and too often. I give unsolicited feedback on my experiences in real time, constantly. This, it is implied, is a rival to the market. Perhaps I think that I live in East Germany?

I call hotlines and complain when restaurant service is less than stellar. I fill out comment forms. I spend a great deal of time responding to surveys for those companies that I patronize often. Does any of this make sense?

The great thing about a market economy is that unsuccessful businesses are allowed to fail. But we are reminded all the time of businesses that are both failures (based on the promise of a certain level of service) and good enough to stay in business. How is it that this persists in a market economy? See Alchien.

This results from an overly simplified dichotomy between patronage or not. The typical response is to say that there are many imperfections in the market. We see barriers to entry and we see large firms that have brand recognition survive just on the fact that people know the quality of the product they will receive.

Does this dichotomy make us abandon the market concept? I think there is a difference between a cold Burger King sandwich that is supposed to be hot and a full-blown socialist economy. Ironically, the perfectly discriminating monopoly gathers more information than the perfect competition model.

Why would anyone give other types of feedback. I have debated people in the past who assert that market prices contain all relevant information. Certainly over large arcs this could be useful in predicting who stays in business, but there are significant sources of information that cannot be reduced to price. We can simply start with the hypothesis that businesses that do not have customer feedback will not stay in business, and if shown to be false, assume that customer feedback is irrelevant.

I prefer to think about markets as more complex. Price is a good first approximation. There are a number of things that can be better understood by prices in a thick market. However, as soon as you remove the assumptions 1) non-bundled goods and 2) thick market; we are in a different territory altogether. Most goods are bundles. Even a cone of ice-cream is a bundle of services rendered and location. Further, imagine an ice cream good enough to justify a sub-par cone...

How we talk about cost without simplifying this to simply the realized money-price is important. I continue to exploit the opportunity to raise non-price costs for bad behavior because I believe that all things too have downward sloping demand curves vis-a-vis disapprobation and upward sloping supply curves vis-a-vis approbation. This encourages my tendency to complain...

Are Fast Food Items a Market Failure?

As I write this I notice that I have once again chosen a bad (for by health) meal for lunch today. Being that I "know" I wanted to eat healthier, it is hard to explain my choice for the convenience of TacoTime over the more difficult process of thinking about how to get a healthier meal [demonstrated preferences]. This must mean one of two things is going on:

In the first case, I could be a victim of perverse incentives. Perhaps it is the market's fault that my particular preferences are not available in the market. I would like either something that is salad based or something that is bean based that I could get at the drive-thru window of a restaurant. Maybe we, as a fast-food eating nation, are just stuck in bad habits.

The second case, I could simply be confused about my preferences. I didn't even look on the menu to see if there were bean based options on the menu. It is a "Mexican" place after-all. [I just checked, they have veggie and bean burritos, BTW]. What sells, after all, is not the most healthy food option.

Neither of these satisfies my conflicted desires. I think to myself there should be more healthy options when I need a fast food lunch. Menus need more options and maybe I would find something that I both like and is good for me. I would still need it to be prepared quickly and packaged conveniently. It would be so much better if I could change everyone else's preferences to suit my vision of myself as a better person.

One such plan is to tax foods that make people obese. The idea is that these foods, because they are both cheap and delightful are over-consumed. Americans are certainly fatter, but are they happier? The claim is that they are happy in the moment but are not correctly accounting for the cost later on. Fatty foods and lots of meat is unhealthy. Besides this, the social cost of obesity raises the cost to provide universal health care. This social cost seems to dictate that something be done [assuming we hold the provision of universal care constant].

What would a world look like with a fast-food tax? Well, maybe McDonald's would have a new menu that complied with a heath food, fast food regulation. This would force the company to invest in packaging that could keep fruits and vegetables fresh and appetizing. Perhaps if beans and lettuce were not taxed like hamburgers and tacos, it would be easier for these restaurants to achieve scale in the more healthy items, which would help with the diversity of options and the packaging choices.

But I think instead this type of fast food would lose business, and the consumer would lose a very quick meal option. I just don't buy it that people will make special plans to go and eat salad at their local McDonalds. Perhaps fast-food should go out of style. But I tell you, as I write this, I am appreciative of not having to make my own meal for lunch so that I could have time to think about the economic implication of that meal instead.